So far this year, checking your investment account balances could lead to an upset stomach, or worse. You are better off watching the historically unusual 2016 presidential campaigns. That way, you have enough to distract you from making a bad investment decision … even if Donald Trump or others upset your stomach.
What would a bad decision be? Here are several worries you may have, stated as “oh no,” along with a description of the potential bad investment decision:
“Oh no, stocks are too risky, I’m moving my money over bonds instead” – a.k.a., changing your portfolio allocation
If you (and your advisors) constructed a good long-term portfolio, then stick to the allocation in your portfolio. At present, the return on most bonds is less than the rate of inflation, after income taxes. The return on money markets is even less. So, unless you have amassed huge sums, you need the stock market returns to reach your financial goals.
That means you have to stay in stocks, and ride out the current downturn.
“But does that work?”
Let’s take the last big market dive of 2008 as an example. Measuring stock performance from 2008 through 2012, “the S&P 500 generated a cumulative return of 8.6 percent.” See Went to Cash? Here’s the next Big Mistake You’ll Make.
Have you seen any bonds paying 8.6%?
I didn’t think so.
True, there are alternate investments, such as hedge funds, precious metals, commodities and raw materials, which could perform better than bonds. However, each has different risks and expenses, and some of these have high barriers to entry. If any of these investments do belong in your portfolio, they are there to balance your other investments, which must still include stocks.
“Oh no, investing is too risky, I’m putting my savings in cash for now” – a.k.a., attempting to time the market
Pulling out of the market when it goes down and then putting all that cash back in just before it goes back up sounds great. However, the problem with market timing is no one can do it. Looking at 2008 through 2012, “If an investor missed the 36 percent drop in the S&P 500 in 2008 — or even worse, bailed on the markets mid-carnage — they probably also missed the 26 percent gain in the S&P 500 in 2009, and the next three positive years for the index that followed. See Went to Cash? Here’s the next Big Mistake You’ll Make.
So, you are thinking that 2008 to 2012 is an aberration.
“Yes, I still want to move to cash.”
Then consider 1970 to 2016, where, if you missed just the best 25 days out of 11,620 trading days, “your returns would have gone from 1,910% to 371%, or [from] 6.7% a year to 3.4%. To give you an idea of how lousy that is, 1-month U.S. T-bills returned 4.9% over the same period.” See How missing out on 25 days in the stock market over 45 years costs you dearly.
The challenge of timing the market is capturing the best days. However, Nobel laureate William Sharpe “found that market timers must be right an incredible 82% of the time just to match the returns realized by buy-and-hold investors.” See Why you should stay in the stock market.
Are you that lucky?
“Oh no, China is a total mess, this time is different, I’m am getting out of stocks forever” – a.k.a., attempting predict the future
True, the slowing of the Chinese economy is causing economic problems worldwide. But, in terms of the impact on stock markets worldwide, that is not dramatically different from the 1987 crash, only then it was Japan.
“Yes, but my friends are selling stocks …”
Did you know that the individual investor is a contrary indicator for the stock market?
“What does that mean?”
Historically, when individual investors are selling, that is a market low, a good time to invest. Similarly, when individual investors are putting everything into the stock market, that is a market peak and a time to sell the over-priced stocks.
By the time you realize that you are mistaken, you will have missed much needed performance. For emphasis, consider this:
From 1990 to 2005 a $10,000 investment would have grown to $51,354 had you just sat tight from beginning to end. However, if you had missed the best 10 days in that 15-year period, your returns would have dwindled to $31,994; if you had missed the best 30 days, you’d be looking at a mere $15,730. Why you should stay in the stock market.
“Oh no, investing is too risky, I put my savings in cash” a.k.a., thinking short-term, another argument for going to cash
he stock market has to be risky, otherwise there would be no reward for investing.
“But I like cash!”
Cash is not volatile, but it is still “risky” – the return on cash – the interest earned – is less than the rate of inflation. Over time, investing only in cash puts you far behind, while long-term investing reduces the risks of stocks. The key is, you have to withstand the downturns to gain from the upturns:
A study by SEI Investments reviewed all the bear markets since World War II. According to the study, reported in The Wall Street Journal, stocks rose an average of 32.5% in the 12 months following the bear-market bottom. Yet, if you missed the bottom by just a week, that return fell to 24.3%. Waiting three months after the market turned cut your gain to less than 15%. Why you should stay in the stock market.
“Oh no, I need money to buy a house” – a.k.a., having the wrong investment strategy
What was your short-term investment doing in the market in the first place?
“I need my money to double so I can buy my dream house!”
Sorry, if you need that much then your dream is wrong.
For the stock market, anything less than 5 years is “short term.” If you have money set aside for a vacation, new car or other major purchase, like a house, those funds need to be invested more conservatively, taking less risk. Otherwise, while you could double your money in a couple of years, you could also end up with much less.
“Oh yes!” a.k.a., the conclusion, an important message – don’t forget it:
After watching investors for several decades, I know this to be true: you must create a good investment strategy and stick to it for it to work.
Even if do not have an optimum strategy, your investments will perform far better than someone who keeps altering their strategy.
“But the fund I have didn’t do as well as another fund last year, so I am selling ….”
Chasing after the last year’s star mutual fund usually works out poorly. You sell your current fund, paying fees and taxes, to buy the star fund, only to watch its performance return to the mean. Disappointed, you then sell the new star fund to chase another star performer, only repeat the same mistake with fees and taxes. After you repeat this a few times, you could end up with negative returns while someone who simply a bought and held a mediocre fund will have substantial gains.
If your investment strategy is better than mediocre, and it includes stocks, stick with it!
“Okay, I will.”
Good, the future you, sitting on a beach sipping drinks with paper umbrellas, will be so glad you did!